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A hedge fund holds a long position in ABC Corp. The fund uses S&P 500 Index...

A hedge fund holds a long position in ABC Corp. The fund uses S&P 500 Index futures to eliminate the systematic risk of its position in ABC. How would an increase in ABC's non-systematic risk affect the hedging effectiveness of the fund's hedged position in the stock?

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Expert Solution

Non systematic risk is a risk related to firm specific factors so when there will be a non systematic risk related to exposure into a stock,it will mean that the stock will be showing the movement in isolation with the movement of the indices so standard and poor 500 will not be showing the movement in the same direction of the ABC crop and it would be leading to risk related to hedging because the hedging company has discounted the systematic risk not the nonsystematic risk, and because of the Increase of the non systematic risk of the company & it is not moving in line with the standard and poor 500 and it would be resulting into a loss for the company as hedging will be ineffective.

jeff jeffy answered 2 years ago
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